LeoGlossary: Dotcom Bubble
Also known as the Tech Bubble, Dotcom Boom, and Internet Bubble
This was an era in the late 1990s into the early 2000s where the equities market went crazy. It was driven by the excitement regarding the potential of the Internet, with many investors getting excited over the stocks related to that sector.
During the period between 1995 and early 2000 saw the NASDAQ climb 400%. This was followed up by a drop of 78% by 2002. It took that exchange more than a decade to reclaim the all time high set during the Dotcom Bubble.
The bubble was able to give high valuations to a lot of companies such as Yahoo, Cisco, and Amazon. Many of these saw their market capitalizations wiped out. They, however, were the fortunate ones since they remained in business. Companies such as Webvan and Pets.com hand to file bankruptcy.
A number of communication companies also had to close up shop. Worldcom, Northpoint, and Global Crossing all exited the world of business.
It is not uncommon for technology to fuel a lot of speculation and, as a result, see bubbles in the markets. This is actually rather common.
Over the last 150 years, a similar things happened to:
- home computing
The Information Super Highway
By the middle of the 1990s, the phrase "Information Super Highway" was being discussed in many circles. The Internet was bringing a new era in communication and a lot of people were excited to get on board.
Throughout that decade, companies engage in massive Information Technology (IT) spending. As they modernized their systems, revenues of many infrastructure providers shot up. This was coupled with advancements in personal computing. The combination was a powerful motivator for investors.
There was also progress being made for the users. The introduction of the World Wide Web made the Internet a more user friendly experience. Mosiac and other web browsers brought forth an easy way for people to "surf the net". While usage remain low, it was easy to see how this new medium could explode.
Another thing that was being touted was the reduction of the digital divide. As computing was made more accessible people were able to log onto the Internet. This was now a medium that added the idea of networking to the equation. Computer nodes all over the world were starting to communicate with each other.
As the decade progressed, the vision was being painted. Even though few truly understood what was taking place, they bought into the concepts. Nowhere was this less true than Wall Street which is always willing to buy into hype.
By the time the decade closed out, the hype reached epic proportions. The Dotcom Bubble was driven by more than just hype.
There were a couple of significant events tied to this era which made the Bubble possible.
The first was the Telecommunications Act of 1996 which was signed by President Bill Clinton. It was meant to unleash a flurry of investment and activity by providing a competitive environment. Basically, this removed all barriers between telecommunication industries, allowing anyone to compete in any other market. The idea was to allow multiple players in broadcast, Internet, and other media channels vie for spectrum. Sadly, the net result of this act appears to be the formation of major media giants.
Nevertheless, this law captured the imagination of not only the public but brokerage firms all over the world.
Another factor was the reduction in taxes. This period saw a reduction in the top margin for capital gains taxes. This obviously made investing more enticing as the tax hit was less.
The final potential piece was the reduction in interest rates by the Federal Reserve. Alan Greenspan, then Fed Chair, was one who understood markets more than most people in his position. He did put a positive tone to the valuations which helped to soothe those worried about things getting out of hand. Sadly, his understanding of markets did help to push things past where they were sensible.
Profits Don't Matter
As the bubble starting to accelerate, the media piled on board. The financial media was filled with people discussing the idea of how profits no longer mattered. This was, after all, the "new economy" and it was not wise to be left out.
Venture Capital firms also started to get wild. There were people dropping out of prestigious schools such as Harvard to "build an app". While many did not understand what that really meant, it was able to garner millions of dollars in funding.
This ended up being a sunk cost in the end.
Retail investors also swooped into the markets like never before. With information becoming readily available, thanks to the Internet, people felt more confident in their investing. This led to people getting caught up in the sentiment of the time. It was not uncommon for people to be buying stock using their credit cards.
Unfortunately, for a number of years, this was a profitable approach. When the bubble was mounting, anything tied to the Internet saw price increases. Speculation took over completely. It really did not matter what the interest rate was on the card, the stock was covering the APR in a month.
This era was marked with an extreme amount of FOMO. People were sinking any liquid cash they could into the market. Naturally, this could not last as insane speculation always comes to an end.
Was the height of the absurdity the merger between AOL and Time Warner?
This was touted as a blending of the old with the new. Time Warner was a historic name in the entertainment industry. In January of 2000, there was an announced merger between the two companies. This would ultimately be a $360 billion merger, with AOL shareholders receiving 55% of the new company. Here is where we see the valuations being placed on the Internet companies was truly insane.
When the revaluation took place, the was a drop of $120 billion, all coming from the adjustment of the AOL part of the entity.
All bubbles do come to an end.
There were a number of events that happened in 2000 that played into the grounding of the stock market. One was the fact Japan's economy was back in recession. This was a major hit as it was still one of the leading economies at the time.
Greenspan also went on a rate hiking spree. This caused the inexpensive, easy money to dry up. It is a move that affected everything from investment by companies to margin trading.
The period of "profits don't matter" ended with a thud. News started to spread that the Internet companies were running out of money. While the model was to forgo revenues in pursuit of network effects, a period without abundant capital meant those without profits were in trouble. This naturally bled into markets as people started to rightly question the viability of what was taking place.
Perhaps the final dagger in the bubble was Microsoft being dragged into court for violating the Sherman Act. The government was trying to make the case the company was a monopoly. It was a matter that was not taken lightly by the markets.
The next couple years saw a prolonged period of bad news. First there was the September 11 attacks followed by a number of accounting scandals which shook Wall Street. Corporations such as Adelphi and Enron rocked the markets.
The Dotcom bubble became the symbol for greed, excess, and FOMO. What happened after the bursting was the evaporation of trillions of dollars in market cap. People lost their entire investment in many of the corporations they were involved with. This translated into the job market as a recession griped the economy.
Today, with Tulip Mania, the Dotcom era is known for its bubble. Each time irrational exuberance takes hold, it is usually compared to this era.
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